INTERNATIONAL FINANCIAL MANAGEMENT

INTRODUCTION: MULTINATIONAL ENTERPRISE AND MULTINATIONAL

FINANCIAL MANAGEMENT
Companies today operate within a global market-place. To support this global
market , there is a need for internationalisation of finance and commerce and
such need was realised through the advancement in transportation,
communications and information processing technology. The focus is on
dependable, quality and world-class product at aggressively low price. Market
globalisation introduces global competitors, making firms insecure both domestic
and internationally.
CATALYSTS FOR GLOBALIZATION
Fundamental politic, technology, regulatory and economic forces changed the
global competitive environment; price and service competition. Some of the
forces that propel globalisation and forces the global market place to be
competitive both in price and service are:

Massive deregulation
Collapse of Communism
Worldwide sale of state-owned firms in privatizations
Revolution in information technologies
Rise in the market for corporate control takeovers, mergers,
leveraged buyout and private equity transactions with the objective
to widen market share.
Replacement of statist policies by free-market policies in many
Third-World economies and with nations putting themselves like
giant corporation enforcing the standard and competitiveness of the
global marketplace.

IMPLICATIONS OF GLOBALISATION
Todays firm is part of an extremely competitive and integrated world economic
system. They must increasingly turn to foreign market to source capital and
technology and sell their products. They must be able to utilize resources from
around the world in order to operate efficiently and effectively, obtain superlative
performance, achieve competitive advantage in an increasingly competitive
business world. The key to international competitiveness is the ability of
management to adjust to change and volatility at ever faster rate.
The rapid pace of change means the global managers need detailed knowledge
of their operations; how to make the products, where the raw materials and parts
come from and how they get there, the alternatives, where the funds come from,
what their changing relative values do to the bottom line.
Firms need great flexibility; they must be able to change corporate policies
quickly, as the world market creates new opportunities and challenges. They
must understand the political and economic choices facing key nations and how
those choices will affect the outcomes of their decisions.

The international mobility of capital has provided more financial options while
simultaneously increasing complexity.
Where in the world should the plant be located? Which global market segments
should the firm seek to penetrate? Where in the world should the firm raise its
finances? The firm must be aware of the constant changes of the option and the
subsequent decisions/choices to be made in respect of plant locations worldwide,
most cost-effective mix of supplies, components, transports and funds. Global
managers must anticipate, understand and deal with changes and make
decisions to enhance the companys prospect for survival, growth and
profitability.

Companies must be able to quickly adapt their policies to respond

to new global market opportunities and challenges.
The international mobility of capital has provided more financial
options while simultaneously increasing complexity.
Global managers need in-depth knowledge of their operations.
How their products are made
Their supply chain, alternatives
Where the funds come from
How their changing relative values affect the bottom line.
Global managers must understand the political and economic
choices facing key nations and how those choices affect the
outcomes of their decisions.

CONSEQUENCES AND CRITICISM TO GLOBALISATION

Globalization opens the world economy but it also created threat.
positive notes, globalization has the following consequences:

On the

The global rationalization of production is driven by global

competition.
Free trade allocates resources to their highest valued use.
Globalization fosters creative destruction continuous change;
out with the old, in with the new; i.e.:
Some industries advance, others recede;
Jobs are gained and lost;
Businesses boom and go bust; and
Some workers must change jobs and occupations.
Consumers benefit from lower prices and expanded choices.
Globalization enables nations to get richer together (i.e., expands
the economic pie for all parties).

Critics label local firms that invest abroad as job exporter and the sale of local
assets to foreign ownership as sale of sovereignty. However, it was proven that
foreign-owned companies are more productive and yet no loss of sovereignty is
experienced by the home countries. Global rationalization of production will
continue, as it is driven by global competition. The end result will be higher living
standards brought about by improvement in workers productivity and private
sector efficiency.
Free trade and competition allocate resources to the highest valued use.
Companies have to adopt new technologies, improve production methods,
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explore new market and introduce new and better products. Consumers benefit
from lower prices and expanded choices. Workers benefit by doing things that
they are best suited.
Critics also cited that by going overseas, home countries are losing jobs as well
as forced down average worker compensation (wages and benefit) due to
competition from low-cost foreign workers. Record however indicated that
productivity increased and compensation risen in line with increased productivity
in order to starve off the foreign competition. Globalization is not a zero-sum
game; where wins for some must be result in loses for others. Instead,
globalization expanded the total economic pie, enabling nations to get rich
together.
THE RISE OF MULTINATIONAL CORPORATION
A Multinational Corporation (MNC) is a company engaged in producing and
selling goods and services in more than one country. It consists of a parent
company located in the home country and foreign subsidiaries, typically with a
high degree of strategic interaction among the units e.g. sourcing in one country,
production in another country, distribution and retail in still another country ; a
commercial mix that best suited the MNCs. What differentiates the multinational
enterprise from other firms engaged in international business is the globally coordinated allocation of resources by a single centralized management. MNC
emphasizes group performance rather than the performance of its individual
parts.
Industries differ in their importance to foreign operations e.g. oil and gas are
more global than automakers. Even within industries, companies differ in their
degree of internationalisation. In oil and gas for example, PETRONAS and
ExxonMobil
generated 40% and 70% revenue from foreign operation
respectively. Foreign operation can be from internationalization of home
companies or foreign direct investment i.e. the acquisition abroad of companies,
properties or physical assets .
RATIONALE FOR MULTINATIONAL CORPORATIONS
The classical theory of international trade rest on comparative advantage,
where each nation should specialize in the production and export of those goods
that it can produce with the highest relative efficiency and import those goods
that other nations can produce relatively more efficiently. The theory was made
on the assumption that goods and services can move internationally but factors
of production, such as capital, labour and land are immobile. Classical theory
assumes that countries differ enough in terms of resources endowment and
economic skills to be the centre of economic competitiveness.
The above classical theory is becoming increasingly irrelevant as differences
among corporations are becoming more important than aggregate differences
among countries. Countries now move their factors of production more rapidly in
search of higher returns.

Search for Raw Materials raw material seekers were the earliest MNCs
e.g. East India Companies, that exploit raw materials that could be found
overseas. This continued with petroleum exploration by MNCs like
Standard Oil and British Petroleum. The role of natural resources has
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however diminished in national specialization as advanced, knowledgebased societies move rapidly toward artificial materials and genetic
engineering.

Capital moves instantaneously around the world. Capital raised in London

on Eurodollar market may be used by a Swiss-based pharmaceutical firm
to finance the acquisition of a German equipment by a subsidiary in Brazil.

Labor skills are no longer fundamentally different i.e. learning

institutions have many foreign students making knowledge and skills
equally spread worldwide.

Technology and know-how are rapidly becoming a global pool.

Effective Usage of Available Factors of Production - the ability of

MNCs to use these globally available factors of production fosters
international competitiveness to a far greater degree than macroeconomic
differences among countries. The export of finished products has been
replaced with one in which value is added in several different countries.

Market Seeking - MNCs firm-specific advantages can be profitably

applied to foreign markets e.g. IBM, Nike, Coca-Cola. They maintain global
manufacturing, marketing and distribution network to derive foreign
revenue. Among the advantages of the MNCs are:

Products/processes their products may be well demanded

worldwide while the processes are unique.
Technologies well known, tested and of superior quality.
Patents
Specific rights, knowledge, and skills on factors like information
gathering, organizational and distribution skill to sell oversea.
Exploitation of foreign markets may be possible at considerably
lower costs. This is done through the revenue derived from wider
market to absorb high research and development cost at home.
Foreign markets provide opportunities for MNCs to achieve
economies of scale and exploit premiums associated with strong
brand names e.g. Nokia. Unit cost decreases with higher volume of
production. Product with substantial fixed cost/overhead need
volume selling to breakeven. Large volume sale can be achieved
through global selling.

Cost Minimization - costs can be minimized by combining production

shifts with rationalization and integration of the firms global
manufacturing facilities; i.e., plants specialize in different stages of
production e.g. Barbie. The integration of worldwide operations must be
complemented by flexibility, adaptability and speed to capture customers
who demand for constant innovation and rapid, flexible response.
Firms that strategize on cost as a key consideration must develop a
global-scanning capability to seek out lower-cost production sites or
production technologies worldwide.

Knowledge Seeking - some firms enter foreign markets to gain

information and experience to use in other markets. The flow of idea is not
one way but reciprocal and synergetic in nature for a win-win situation
e.g. Proton (Lotus).

Keeping Domestic Customers - MNC suppliers follow customers abroad

to guarantee them a continuing product flow and reduce the risk that their
customers will find an alternative local supplier e.g. Nestle instant noodles.

Exploiting Financial Market Imperfection - operating in numerous

countries with different economic cycles reduces systematic risk and risk
relating to exchange rate fluctuations, currency controls, expropriation,
and other foreign government interventions (diversification effect). FDI
capitalizes on the financial market imperfection; the ability to reduce taxes
and circumvent currency controls may lead to greater projected cash flows
and lower cost of funds.

THE PROCESS OF OVERSEAS EXPANSION BY MULTINATIONALS

Firms become MNCs by degree that is, globalization does not initially occur
through conscious design but is the inevitable outcome of the competitive
pressures in oligopolistic/ever-changing industries. Typical sequence of
transitioning strategy from a domestic firm to an MNC is exporting, setting-up a
foreign sales subsidiary, securing license agreements and eventually establishing
foreign production. Each sequence enables firms to move from a low-risk, lowreturn export strategy to a higher-risk, higher-return strategy emphasizing
international production.

Exporting - making product domestically and selling them abroad.

Exporting has the advantages of low capital requirements and start-up
costs, low risk, immediate profits and firms learn about present and future
market conditions, local competition, distribution channels, payment
conventions, financial institutions, and financial techniques.
The disadvantages is the inability to realize full sales potential.
Companies then extend their marketing organization abroad, switching
from using export agents and other intermediaries to dealing directly with
foreign agents and distributors. As increased communication with
customers reduces uncertainty, the firm might establish its own sales
subsidiary and new service facilities culminating in the control of its own
distribution system.

Licensing alternative or precursor to overseas production. One

organization giving another organization the right to use its brand name,
technology or product specification in return for a lump sum payment or
fee (royalties). Licensing is primarily used by manufacturing organization
that make or sell another companys products e.g. Anheuser-Busch InBev
(Budweiser) and franchising is primarily used by service organization that
want to use another companys name and operating method e.g. KFC
Advantages in licensing include minimal investment, faster market-entry
time and fewer financial and legal risks. The disadvantages are its cash
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flow is relatively low, risk of product quality problems and the d ifficulty of
the licensor in controlling exports by the foreign licensee resulting in the
licensee may become a competitor to the licensor in the world market.

Overseas Production - by manufacturing abroad, the advantages gain

by a MNC include being able to keep abreast of market conditions and
adapt products to changing local tastes and conditions, faster order
fulfillment, ability to provide more comprehensive after-sales service,
conveys commitment to local market and ensures certainty of supply.

Associated with a firms decision to produce abroad, a key decision is whether

it should create own affiliate or acquire a going concern i.e. existing firm.
Advantages of acquisition is the capacity to effect speedy transfer of parent
skills, ready-made marketing network, and
local market/technology
knowledge; but may be more costly than creating affiliate.
Generally, the larger and more experienced the firm, the less it relies on
acquisitions.
TRADE-OFFS
EXPANSION

BETWEEN

ALTERNATIVE

MODES

OF

OVERSEAS

Certain general circumstances of the firm can be used to decide whether its
overseas expansion should be in the form of exporting, licensing or local
production. The key factor is the MNCs intangible capital that is, trademarks,
patterns, general marketing skills and other organizational abilities.
If this intangible capital can be incorporated into a standardized products
without adaptation, then the mode of overseas penetration should be
exporting. Where the firms intangible capital is in the form of knowledge on
product/process technology that can be codified , written down and
transmitted objectively, the foreign expansion will be licensing.
Where intangible capital takes the form of organizational skills that are
inseparable from the home firm itself, where the home expertise is critical to
support operations then establishment of overseas production is the
option provided that the benefits of circumventing market imperfections
outweigh the costs of central control.
Where economic imperfection make it difficult to expand overseas, firms can
consider internalization and hence foreign direct investment (FDI) i.e. the
acquisition abroad of companies, properties and physical assets. Two types of
overseas investments are available namely vertical investment and
horizontal investment.

Vertical Integration
Direct investment across industries that are related to different stages of
production of a particular goods, enables the MNCs to substitute internal
production and distribution systems for inefficient markets. For example,
Proton which manufacture cars also own a company that make tyres.

Horizontal Integration
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Investment that is cross-border but within and industry enable MNCs to

utilize an advantage such as know-how or technology and avoid the
contractual difficulties of dealing with unrelated parties. Horizontal
integration (also known as lateral integration) simply means a strategy to
increase your market share by taking over a similar company. This take
over / merger / buyout can be done in the same geography or probably in
other countries to increase your reach e.g. Google took over You Tube
primarily because You Tube has a strong and loyal user base. By doing that
Google increased its viewers.